ACC2642

INTRODUCTION TO MANAGERIAL ACCOUNTING

QUESTION BANK (UNITS 1 – 4)

2019
UNIT 1: OVERVIEW TO CORPORATE FINANCIAL MANAGEMENT
QUESTION 1 (20 MARKS)

(a) Explain the meaning of agency problem and discuss how shareholders of a company
try to overcome costs associated with the agency problem. (5)

Solution:

Meaning of agency problem:

- The management of many large listed companies own a very small proportion of the
equity of a company.√
- The management are agents of the shareholders and should take actions to maximise
the wealth of shareholders. Yet there could be a conflict of interest where management
take actions that maximise their own remuneration and perks at the expense of
shareholders. √
- Management could have a greater preference for expenses that result in direct or
indirect benefits for themselves. This could be indicated by excessive remuneration
levels, expensive corporate jets and head office structures. √
- Further, management will be more risk averse than shareholders as their position and
survival is determined by the survival of the firm, whilst shareholders will own a
diversified portfolio. √
- Management may endeavour to maximise the size of the firm and undertake
unnecessary diversification to ensure a continuation of their position. √

How shareholders of a company try to overcome costs associated with the agency problem:
- The threat of any take-over will ensure that management will act to maximise the share
price and thereby make any potential take-over much more expensive and reduce the
willingness of shareholders to accept any offer. The management of poor performing
companies are often replaced in a take-over. √
- Management incentives such as share options, which are linked to the share price and
performance bonuses that are linked to variables such as accounting earnings or
operating cash flow. √
- The shareholders can appoint the board of directors that may change the Management
team if performance is inadequate. √
- The market for managers may mean that to move up the CEO ladder, management will
have to show excellent performance. If management is easy to replace than
 management will be motivated to perform, although this may only reflect short-term
performance, which may be at the expense of longer-term performance. √
- The growth of institutional investors, which now hold onto sizable shareholdings in
many companies means that these investors have become increasingly ready to act to
use their voting rights to replace poor management. √
Max 5 marks

(b) Corporate financial management involves making three basic decisions namely capital
budgeting decision, capital structure decision, and working capital decision. Write short notes
on each of these decisions. (15)

Solution:

Capital budgeting decision

What should the business invest in?

 Financial management has to determine what assets are required by the business and evaluate
this based on capital budgeting techniques, and how to finance it at the lowest cost possible. An
understanding of the balance sheet is vital for any manager.
 Financial manager should aim to create value
 Will do that by identifying investments that will create value
 Determine cash flows
 Size – how much initial investment is needed and how much income will be received
 Timing – when and for how long income will be received
 Risk – the likelihood of receiving the income
 Will income from investment exceed the cost?

Capital structure decision

Where will the business get long-term financing to pay for the new investment?

 The mix of debt and equity a company uses to fund new investments/projects
 Three choices available:
 Borrow long-term funds (debt) – risk increase
 Use savings of the company (retained earnings)
 Issue more shares (equity) – ownership declines
 Whichever option will have an effect (risk and value)
 Which form of financing is the cheapest?

Working capital decision

How will the business manage its day-to-day financial activities?

 Working capital = short-term assets and liabilities

 How will you approach the day-to-day financial management?
 Will you sell new product for cash, credit or both?
 Who will receive credit and who won’t?
 How many days until debtors have to pay?
 Will you pay expenses in cash or on credit?
 All these decisions are important to ensure business functions efficiently
 There must be sufficient resources for adequate liquidity

(c) Differentiate between shareholders’ wealth maximisation and profit maximisation. (5)

• Number one goal = increase the wealth of the shareholders

• How can that be done?

 Shareholders can receive dividends

 Increase in the share price

• If a financial manager focuses on shareholders’ wealth maximisation, then both risk

and return are taken into account

• Profit maximisation: short-term goal not looking at long-term effects

• Share price maximisation: short-term and long-term

• Every decision in the best interest of the shareholders

UNIT 2: TIME VALUE OF MONEY

QUESTION 1 (20 MARKS)

(a) Differentiate between simple interest and compound interest. (2)

Solution:

Simple interest refers to calculation of interest on the principal amount only (1)

Compound interest is calculated on principal amount plus the reinvested interest amount. (1)

(b) On completion of his bachelor’s degree, Roland gets a job as a trainee accountant at
a local bank. The bank offers him a 4-years loan requiring monthly repayments of
R1 053.35 at 12% per annum compounded monthly. Calculate the principal amount
that Roland would have borrowed from the bank. (3)

Solution:

Using a financial calculator

FV= 0

N= 12x4= 48 (1)

I= 12/12= 1 (1)

PMT= R1 053.35

PV= R1 053.35 x 37,974 = R39 999.91 (Table 2A Present value for ordinary annuity) (1)

(c) You have been hired as a financial advisor to Oupa Manyisa, a South African
professional footballer. He has received two offers for playing professional football and
wants to select the best offer, based on considerations of money only as he wishes to
prepare for his life after the soccer playing career. Offer A (a move to Sundowns
Football Club) is a R10m offer paying R2m a year for the next 5 years. Offer B (to
remain at Orlando Pirates) is a R11m offer of R1m a year for four years and R7m in
year 5. Advise Oupa Manyisa on the better option assuming an annual interest rate of
12%. (6)
Solution:
Option A

Table 1A Present value for a single amount or Discount rate = 1/(1+r)n

Year Cash flow Discount rate @12% Present Value

1 2 000 000 0.8929 1 785 800 ½
2 2 000 000 0.7972 1 594 400 ½
3 2 000 000 0.7118 1 423 600 ½
4 2 000 000 0.6355 1 271 000 ½
5 2 000 000 0.5674 1 134 800 ½
Total PV R7 209 600 ½

OR

NB: Because the cash flows are the same. That is there are no mixed cash flows, you can
use a financial calculator to compute PV.

PV= ?

N= 5 (1)

I= 12 (1)

PMT= -2 000 000 (1)

Compute PV= R 7 209 552.40 (1)

Option B

Table 1A Present value for a single amount or Discount rate = 1/(1+r)n

Year Cash flow Discount rate Present Mark

@12% Value Allocation
1 1 000 000 0.8929 829 900 ½
2 1 000 000 0.7972 797 200 ½
3 1 000 000 0.7118 711 800 ½
4 1 000 000 0.6355 635 500 ½
5 7 000 000 0.5674 3 971 800 ½
Total PV R6 946 200 ½

I would advise Option A to Oupa Manyisa as the Present value of R7 209 600 is higher than
that of option B of R6 946 200. (1)
(d) Suppose you borrow R100 000 from FNB Bank at an annual interest rate of 11% per
year, interest compounded annually and repayment over the next 5 years in equal
yearly instalments.

REQUIRED

(i) Calculate the annual instalment assuming that payments are required at the beginning
of each year. (2)
(ii) Calculate the annual instalment assuming that payments are required at the end of
each year. (1)
(iii) Construct the loan amortisation schedule if payments are required at the end of each
year. (6)

Solution:

(i) Calculate the annual instalment assuming that payments are required at the
beginning of each year.

Solution:

Set Financial calculator to BGN mode first

FV= 0
PV= -100 000 ½

PMT= ?
N= 5 ½

I= 11 ½

COMP PMT= R 24 375.70 ½

Or use table 3A Present value for annuity due (R100 000 / 4.102 = R24 378.35)

*Slightly different answers due to rounding

(ii) Calculate the annual instalment assuming that payments are required at the
end of each year
 Solution:

Using a financial calculator

FV= 0

PV= -100 000

PMT= ?

N= 5

I= 11

COMP PMT= R 27 057.03 (1)

Or use table 2A Present value for ordinary annuity (R100 000 / 3.696 = R27 056.28)

*Slightly different answers due to rounding

(ii) Construct the loan amortisation schedule if payments are required at the end of each
year

YEAR INSTALLMENT PRINCIPAL ANNUAL CUMULATIVE PRINCIPAL Mark

PAYMENT PAYMENT INTEREST INTEREST AMOUNT Allocation
OWING AT
YEAR END
0 100 000 1
1 27 057.03 16 057.03 11 000 11 000 83 942.97 1
2 27 057.03 17 823.30 9 233.73 20 233.73 66 119.67 1
3 27 057.03 19 783.87 7 273.16 27 606.89 46 335.80 1
4 27 057.03 21 960.09 5 096.94 32 703.83 24 375.71 1
5 27 057.03 24 375.70 2 681.33 35 385.16 - 1
TOTAL 135 285.15 100 000 35 285.16

* If you used the R27 056.28 from the tables you will end up with a balance of R4,68. This is
due to rounding and you will still earn the same marks.

QUESTION 2 (20 MARKS)

(a) What is the future value of R10 000 invested for two years at a nominal interest rate of
12%, compounded annually? (2)
 (b) What is the future value of R10 000 invested for 10 years at a nominal rate of 10% per
year compounded continuously? How much higher is this value than the value
obtained with annual compounding for 10 years at 10% per year? (3)

(c) Which would you rather receive: the proceeds from a 2-year investment paying 5%
simple interest per year or from one paying 5% per year compound interest? Motivate
your choice briefly. (3)

(d) An investor will receive R110 000 in one year’s time. What is the value of the R110
000 today if the interest rate is 10% per year? (2)

(e) Mr Bond purchased a house for R750 000 and paid a deposit of R50 000. He obtained
a 20-year mortgage loan from ABSA Bank to finance the balance of the purchase price
at an interest rate of 15% per annum, compounded monthly.

REQUIRED:

Calculate the following:

(i) Calculate his monthly loan repayment. (2)

(ii) Construct an amortisation schedule for the first five (5) months if equal
payments are required at the end of each month. (6)

(iii) The revised shortened duration of the loan if the monthly instalment is
increased by R500 from commencement of the loan. (2)

Solution:

(a) FV = R10 000 x 1,12 ^2 = R12 544

(b) Continuously (monthly) = R10 000 x (1,0083^120 = R27 070,41
Annually = R10 000 x 1,10^19 = R25 937,42

(c) Simple interest will pay less than compound in all cases.
(d) PV = R110 000 / 1,1 = R100 000
(e) i. PV = R700 000, I = 15%, n = 20, PMT = R9 217,53
ii.
Month Opening Payment Interest Capital Closing

1 700 000 9 217,53 8 750 468 699 532

2 699 532 9 217,53 8 744 473 699 059

3 699 059 9 217,53 8 738 479 698 580

4 698 580 9 217,53 8 732 485 698 095

5 698 095 9 217,53 8 726 491 697 603

iii.
PMT = R9717,53
PV = R700 000
FV = 0
I = 1,25%
N = 186

QUESTION 3 (20 MARKS)

(a) What is the nominal interest rate if R80 000 yields R120 000 in three years’ time and
interest is compounded annually? (2)

(b) What is the future value of R100 000 invested for one year at a nominal interest rate
of 12% per year, compounded quarterly? (2)

(c) You expect to receive R500 000 in 5 years’ time. Calculate the present value of this
future receipt at the continuously discounted rate of 12% per annum. (2)

(d) The nominal rate of interest on a Bank Certificate of Deposit is 8% per year. If
compounding occurs continuously, what is the effective annual rate? (2)
(e) What is the future value of R50 000 invested for 10 years at a nominal rate of 10% per
annum compounded continuously? How much higher is this value than the value
obtained with annual compounding for 10 years at 10% per year? (3)

(f) Which would you rather receive: the proceeds from a 2-year investment paying 5%
simple interest per year or from one paying 5% per year compound interest? Motivate
your choice briefly. (3)

(g) Suppose you borrow R220 000 from FNB Bank at an annual interest rate of 12%
effective to be repaid over the next 5 years, calculate the annual instalment assuming
that payments are required at the beginning of each year. Also construct the
amortisation schedule. (6

Solution:

a) Factor = R120 000 / R80 000 = 1,500

N=3

I = Between 14% and 15% (14,47% exactly)

b) R100 000 x (1+0,03)^4 = R112 551 (or use table factor 1,126)

c) FV = R500 000; n = 5 x 12 = 60; I = 12% / 12 = 1%

PV = R500 000 x 0,550 (use table) = R275 000

d) Nominal rate is 8% per annum. Effective interest rate = (1,0067)^12 = 8,3%

e) FV = R50 000 x 2,594 = R129 700 if annually

FV = R50 000 x 2,707 = R135 350 if each month

f) Compounded interest

g) PMT = 54 491,20 (Beginning of each period)

N Opening Installment Interest Capital Closing

1 220 000,00 54 491,20 ‐ 54 491,20 165 508,80
2 165 508,80 54 491,20 19 861,06 34 630,14 130 878,66
3 130 878,66 54 491,20 15 705,44 38 785,76 92 092,89
4 92 092,89 54 491,20 11 051,15 43 440,05 48 652,84
5 48 652,84 54 491,20 5 838,34 48 652,86 ‐

QUESTION 4 [25 MARKS]

4.1 You have received an inheritance of R329 760 .You plan to put the entire amount in an account earnings 8%
compounded annually and to withdraw R40 000 at the end of each year. For how many years you can
continue to make the withdrawals? 4 Marks
4.2 Tafadzwa (Student at Univen) who is studying Bcom Accounting managed to acquire an interest free loan of
R80 000.After completing his studies and beginning to work as a Junior Accountant at Shaprite Pty(Ltd),he
saves R15 000 ever year and invests the amount at 12.5% p.a. compound interest.What additional amount
is required to fully repay the loan after 4 years of saving? 6 Marks
4.3 VBB (PTY) Ltd took out a R480 000 loan. The loan is due at the end of 6 years, and the repayment amount
is R779 648.What is the interest rate that VBB (PTY) LTD is charged? 4 Marks
4.4 What is the present value today of the perpetuity that pays R400 per year if the 1st pay payment does not
begin until 4 years hence and if 10% is the relevant discount rate ? 4 marks
4.5 Fhumulani has recently seen a small house around Thohoyandou area close to the university of Venda, that
she would like to buy. She thinks that it will be perfect for a new business: renting out rooms to students
around Univen. The house costs R500 000. Fhumulani’s would like to borrow this money from her parents
and repay them R500 000 in ten years’ time. Fhumulani’s parents (Vho Nyamukamadi na Vho Gilibethe)
burst into laughter when she suggests this deal. Explain why Fhumulani’s parents believe that this is not a
good way for them to invest their pension? 4 Marks
4.6 Name any three elements that affect the time value of money. Indicate the common symbol used for each
element and briefly explain each element. 3 marks

Solution:

4.1
Using a financial calculator:

PV : 329760
I: 8
PMT : -40 000
FV:0
Comp N:14 Years
or
R329 760 = R40 000 (1.08)N
(1.08)N = R329 760 / R40 000 = 8.244 Use logarithms
N = 14 years
4 marks

4.2
Calculations

F.V. of an Annuity = PMT x FVIFA n/r%

= R15000 x FVIFA 4/12.5%
(By interpolation) = R15000 x [4.779 + (4.850-4.779)/2]
= R15000 x 4.8145
= R72218
(By formula)
= R15000 x [{(1.125)4 - 1}/0.125]
= R72217
Amount required = R80 000 - R72217 = R7783 [using the formula]

Comprehensive solution

Strategy

The fact that the loan is interest free means that its present value is also equal to its future value at any
given point in the future. In all cases, this will be R80 000.

We need to work out how much the student will have saved after 4 years (the future value of an ordinary
annuity).

The difference between this future value and the future value of the loan at that point in time (R80 000 as
discussed above) will give us the additional amount required to fully repay the loan.
Note: When considering the time value of money, it is only meaningful to add or subtract cash values if
they are at the same point in time. This requirement is satisfied here, since we will be comparing two
cash values that are both stated as of time 4.

Cash flow diagram

Time 0 1 2 3 4 5 etc

Cash flows 15 000 15 000 15 000 15 000

Calculations

type = annuity (ordinary)

cmp = annually
PM = -15 000
T
r = 12.5% pa = 0.125
n = 4 payments
FV = ? (at time 4)

Using formula: Using tables:

 (1  r) n  1 FV = PMT x FVIFA4, 12.5% (Table B)

 PMT   
FV  r  No values are given in Table B for 12.5%.
 (1.125)  1 4 However, we can get an approximation by
 15000    interpolating:
 0.125 
 15000  4.81445
 72 217 For 12% and n = 4, FVIFA = 4.779
For 13% and n = 4, FVIFA = 4.850

Estimate for 12.5% and n = 4:

12.512 ( 4.850 - 4.779)
FVIFA 4.779 + 1312
4.8145

FV 15 000 x 4.8145

72 218

Conclusion
Additional amount required = R80 000 - R72 217 = R7 783 [using the formula] (6 Marks)
4.3
r = (FV/PV)1/n - 1

By formula = (779 648/480 000)1/6 - 1

= 8.42%
By Tables (1+r) = FV/PV = 779 648/480 000 = 1.624
By inspection: 6 years: 8% = 1.587; 9% = 1.677
By interpolation r = 8% + [(1.624 - 1.587)/(1.677 - 1.587)]
= 8% + .411
= 8.41%

Or Financial Calculator
FV = 779 648
PV= -480 000
N=6
Comp I = 8.4%
4 Marks

4.4
Present Value in 3 years’ time = R400/0.10 = R4 000 (2 marks)
Present Value (today): R4 000/1.103 = R3 005 (2 marks)

Note: The perpetuity valuation formula (PMT/r) assumes that we are standing one period before the first cash
flow, which in this case is year 3. Therefore, we need to discount the value of such perpetuity for 3 years.
4 Marks Maximum

4.5
The main issue is that money depreciates over time.
This is due to a few reasons:
Firstly, inflation currently exists in most economies in the world (this is a sustained increase in the general price
level of goods and services over time). The result of this is that the purchasing power of R1 does not remain the
same. Fhumulani’s parents will therefore be able to buy fewer goods and services with the R500 000 in ten
years’ time as this amount of money has lost value over time. It is also possible that Fhumulani may be unable
to repay her parents if the business does not go well. Her parents are therefore taking a risk if they lend her this
money, and they will want to be compensated for this risk. Finally, Fhumulani’s parents need to continue to
make more money when they are retired as their pension continues to lose value over time while goods and
services become more expensive. To create wealth, they will have to invest their capital in assets or projects that
provide them with a return on their investment (such as dividends, interest or rental). This loss in monetary
value over time is called the time value of money. 4 marks maximum
 4.6.
i. The present value of the money: PV (what the money is worth in today’s terms)
ii. The time period: n (the time span between today and the required point in the future. In (1) above this was ten
years)
iii. The rate at which the present value of the cash flows is expected to change over time: i or rate (the percentage
change in the current value of the cash flows(s) and their future value in annual terms)
iv. The actual cash flows that will take place during the time period: PMT if a regular cash flow and CFn if an irregular
cash flow (recurring regular cash flows over the time period or irregular cash flows during the time period)
v. The future value of the cash flows: FV (what the cash flows will be worth in the future after the required time
period. This is the future equivalent of today’s single or multiple cash flows).

Maximum 3 Marks
Half a mark if the variables are not explained/discussed (1 and half marks maximum)

QUESTION 5 28 MARKS

Consider the following independent time value of money scenarios and answer
the accompanying questions
MARKS

REQUIRED:
Dakalo want to buy a new computer system and the store is willing to sell it
to allow him to make monthly payments. The entire computer system costs
(a) (5)
R3 500. The loan period is for 2 years and the interest rate is 16,9% with
monthly compounding. What will be his monthly payment?
Ndanduleni Rabulasi is looking at two savings accounts:

i. One pays 5,25%, with daily compounding

ii. The other pays 5,3% with semi-annual compounding.

(b) Required:

Which account should he use and why? Show all your calculations for the
(5)
effective interest rates to support your conclusion.

Thabiso (Student at Turfloop) who is studying Bcom Accounting managed

to acquire an interest free loan of R80 000.After completing his studies and
beginning to work as a Junior Accountant at Migeroni Pty (Ltd), he saves
(c) R15 000 ever year and invests the amount at 12.5% p.a. compound interest. (5)
What additional amount is required to fully repay the loan after 4 years of
saving?
 Dakalo is considering an investment that will pay him R1 000 in one year,
R2 000 in two years and R3 000 in three years. If he wants to earn 10% on
(d) (6)
his money, how much would he be willing to pay? Calculate the net present
value for this investment.

Calculate the present value of a growing perpetuity, given the following

information:

(e) Cash flow (CF1) in at the end of the first year: R50 000 (4)
Growth rate (g): 12% p.a.
Opportunity cost of capital (i): 25% p.a.

Thandeka, a former work colleague, is starting a new business and is about

to approach investors for start-up capital. She has no idea how much
interest (or return) these investors will expect on their investment in her
(f) business. Thandeka has asked you to explain the type of factors that
investors consider when determining their required rate of return on any (3)
investment. What will you tell her?

Solution:

a) Number of months = 2(12) = 24

2nd P/Y = 12 [Enter]
FV =0; I=1,40833333 (16.9/12); N=24; PV=-3 500; CPT PMT R172.88 (5 Marks)

b)
First account:
2nd ICONV, NOM=5.25, C/Y=365 CPT EFF
EAR = 5,39% (2 marks)

Second account:
2nd ICONV, NOM=5.3, C/Y=2 CPT EFF
EAR = 5,37% ( 2 marks)

Which account should he choose and why? The one with daily compounding because it gives
interest of 5.39% as compared to 5.37% ( 1 mark)

c) F.V. of an Annuity = PMT x FVIFA n/r%

= R15000 x FVIFA 4/12.5%
(By interpolation) = R15000 x [4.779 + (4.850-4.779)/2]
= R15000 x 4.8145
= R72218
(By formula)
 = R15000 x [{(1.125)4 - 1}/0.125]
= R72217

Alternative:
PV=0;PMT=15 000;i=12,5%;n=4,COMP FV R72 217 (4 Marks)
Conclusion
Additional amount required = R80 000 - R72 217 = R7 783 (1 Mark)

d)
CF; CF0 = 0;
C01 = 1000 [Enter];F01 = 1 [Enter];
C02 = 2000 [Enter];F02 = 1 [Enter];
C03 = 3000 [Enter];F03 = 1 [Enter];
NPV; I = 10[Enter]; CPT NPV = 4 815.93 (6 Marks)

Alternative:
NPV= 1000/1.1 +2000/1.221+3000/1.331
= R4 815.93
e)
PV = Cash flow (CF1) ÷ (i – g)
= R50 000 ÷ (25% – 12%)
= R50 000 ÷ 0,13
= R384 615,38 (4 Marks)

f) At a minimum investors required rate of return will need to compensate her for three factors:
inflation, the opportunity cost associated with the use of these funds, and their risk (that is
future uncertainties about the outcome of their investment).

(3 marks)
 UNIT 3: FINANCIAL STATEMENT ANALYSIS

QUESTION 1 (12 MARKS)

The following are extracts from the financial statements of Garikai Ltd and Jabula Ltd:

Statements of comprehensive income Garikai Ltd Jabula Ltd

Profit before interest and tax 750 000 850 000
Interest payable - (100 000)
Profit before tax 750 000 750 000
Taxation at 28% (210 000) (210 000)
Profit for the period 540 000 540 000

Statements of financial position Garikai Ltd Jabula Ltd

Ordinary share capital (R1 shares) 250 000 250 000
Share premium 250 000 -
Retained earnings 2 000 000 1 750 000
Non-current liabilities - 1 000 000
Current liabilities - -
Total equity and liabilities 2 500 000 3 000 000

REQUIRED:

(a) Calculate the earnings per share for Garikai Ltd and Jabula Ltd. (3)

Profit after tax  Noncontrol ling interest  Preference dividends

Number of ordinary shares

Garika: (R540 000 – R0) / 250 000 = R2,16

Jabula : (R540 000 – R0) / 250 000 = R2,16

Note : Non-controlling interest not relevant here.

 (b) Calculate the return on assets for Garikai Ltd and Jabula Ltd. (3)

Garika: (R540 000) / R2 500 000 = 21,6%

Jabula : (R540 000) / R3 000 000 = 18,0%

(c) Calculate the return on equity for Garikai Ltd and Jabula Ltd. (3)

Garika: (R540 000) / R2 500 000 = 21,6%

Jabula : (R540 000) / R2 000 000 = 27,0%

(d) Calculate the gearing ratio for Garikai Ltd and Jabula Ltd (formula: gearing =
non-current debt ÷ shareholders’ funds). (3)

Non-current debt over shareholders funds

Garika: (R0) / R2 500 000 = 0,0%

Jabula : (R1 000 000) / R2 000 000 = 50,0%

Question 2 (20 marks) Ratio Analyses

Township Limited was founded in the beginning of 2017 and currently operates one brewery
in Johannesburg. Township has a portfolio of three beer brands and one fruit alcoholic
beverage.

You recently read that beer now represents almost 60% of the total liquor market in South
Africa, up from about 38% in 1980. The Fruit Alcoholic Beverage section is small as a
percentage of the total liquor market (about 5%) but it is growing at about 13% per
annum.Township brands are represented as follow in the alcoholic market:

Category Township Brand Competitors

Mainstream Segment Mahafhe Castle Lager, Carling Black

Label

Fast Growing Worthmore Tshibuku Pilsner Urquell, Heineken

Segment (Premium
Segment)

Light Beer Segment Mkomboti Sterling Light, Windhoek

Light

Fruit Alcoholic Beverages Mukumbi (Amarula) Brutal Fruit, Bacardi Breezer

Section

A close friend recently informed you that a guy who studies with him reckons that Township
Limited is growing at a rapid pace and he thinks that it is a very good time to invest in this
company. He guarantees that you can double your money in four years with this share. Your
close friend comes from a rich family and he has some extra cash. He wants to take advantage
of this opportunity and approached you for some financial advice.
Township Limited
Statement of Financial Position as at 31 December

2017 2018

Non-current assets 9,500,000 12,350,000

Plant and equipment at cost 10,000,000 13,000,000

Less: Accumulated depreciation (500,000) (650,000)

Total current assets 3,000,000 3,200,000

Inventory 1,450,000 2,200,000

Accounts receivable 700,000 1,000,000

Cash and cash equivalents 850,000

Total assets 12,500,000 15,550,000

Total equity 5,735,000 8,050,000

Share capital 5,000,000 7,000,000

Retained earnings 735,000 1,050,000

Non-current liabilities 4,360,000 4,850,000

Long term debt (10%) 4,360,000 4,850,000

Current liabilities 2,405,000 2,650,000

Accounts payable 2,065,000 1250,000

Bank overdraft (15%) 980,000

Current portion of long term debt 340,000 420,000

Total equity and liabilities 12,500,000 15,550,000

Statement of Financial Performance
For the years ended 31 December
2017 2018

Revenue 14,900,000 18,300,000

Cost of goods sold 8,940,000 11,400,000

Gross profit 5,960,000 6,900,000

Operating expenses 3,920,000 5,240,000

Depreciation 500,000 650,000

Profit before financing costs and tax 1,540,000 1,010,000

Financing costs 490,000 560,000

Profit before taxes 1,050,000 450,000

Income tax expense 315,000 135,000

Profit for the period 735,000 315,000

Standard Industry Ratios

Gross profit margin 27.0%

Profit margin 8.4%

Return on equity 14.0%

Debtors collection period 35

Days payables (credit purchases) 42

Inventory days 52

Times financing costs earned 4.0

Current ratio 2.0

Acid-test ratio 1.0

Notes:

 All ratios are based on year-end (rather than average) figures.

 Ignore all VAT implications.

 Assume a Tax rate of 30%.

 Net Assets = Total assets minus non-interest bearing current liabilities.

 All purchases and sales are on credit.

 Assume 365 days in a year.

REQUIRED:

a) Calculate the financial ratios for the year ended 2017 by using the financial statements of
Township Limited (Use the same financial ratios as given in the industry table above). (9)

Please show all calculations and round amounts to the nearest two decimal places

Solution:

Figures (R ‘000) Township Limited

Ratio Formulae

2017

Gross profit Gross

=5960/14900 *100 40.00%
margin profit/Revenue

Profit margin Net profit/Revenue =735/14900*100 OR 4.93%

=1050/14900*100 OR 7% 

=1540/14900*100 10.3%

Return on Net profit after

=735/5735*100 12.82%
equity tax/Total equity

Average Account receivables

Debtors /Credit sales * 365
=700/14900*365 17.15
collection
period
 Days payables Accounts payable /
(credit Cost of sales x 365 =2065/8940*365 84
purchases)

Inventory days Inventory/Cost of

=1450/8940*365 59.20
sales

Times interest Profit before interest

=1540/490 3.14
earned and tax/interest

Current ratio Current assets:

=3000:2405 1.25
Current liabilities

Acid-test ratio (Current assets – =(3000-1450):2405

Inventory ): Current
Or 0.64
liabilities
= (700+850):2405

Marks Allocation : Give half mark for each numerator and denominator which is correct

* If a student use average for some ratios, no marks shall be given for that numerator or
denominator since it indicate that a student is not reading a question properly

Maximum : 9 Marks

b) For each ratio calculated under question a above, briefly explain what it is intended to
measure in your own words. (9)

Solution:

 Gross profit margin: Measures the percentage of each sales rand remaining after
the firm has covered its production costs (fixed and variable). 
 Net profit margin: Measures the percentage of each sales rand remaining after the
firm has covered all its production costs and period costs (fixed and variable). 
 Return on equity: A measure of how the shareholders fared during the year. Since
benefiting shareholders is our goal, ROE is, in an accounting sense the bottom line
measure of performance. 
 Average collection period: Measures how fast we collect on the products that were
sold on credit. 
 Days payables (credit purchases): Measures how fast we settle the amount owed
the supplier of our stock who grants us credit. 
  Inventory days: This tells us, roughly speaking, how long we carry or hold inventory
before it is sold. 
 Times interest earned: Measures how well a company has its interest obligations
covered, and it is often called the interest coverage ratio. 
 Current ratio: Because current assets and current liabilities are in principle, converted
to cash over the following 12 months, the current ratio is a measure of short term
liquidity. 
 Acid-test ratio: Excludes inventory from normal current ratio as inventory is often the
least liquid current asset. This is a more detailed measure of short term liquidity. 

9 Marks Maximum

c) In your own words ,what is the motive behind the financial statement analysis which
you have done under part a and part b above. (2)

Solution:

To ensure that the company is:

 Profitable
 liquid enough to meet its obligations as they fall due, 
 to keep an eye on risk and make sure it doesn’t get out of hand, 
 for us to make an informed investment decision and to be satisfied that the
company’s operations are run and managed in an effective and efficient way
and manner
2 Marks Maximum
UNIT 4: RISK AND PORTFOLIO MANAGEMENT

QUESTION 1 (28 MARKS)

Your rich aunt Roseanne has a portfolio of investments. Currently, she has 40% of her funds
invested in Delta Ltd and 60% in Chev Ltd. Her investment broker has provided her with the
following information:

State of the Probability Rate of return if state occurs

economy of
Chev Ltd Delta Ltd
Occurrence

Recession 0,1 –20% –20%

Normal 0,6 13% 15%
Boom 0,3 17% 30%

Please note: Chev Ltd is basically an investment in treasury bills. Thus, Treasury bills are
risk-free securities. As such, they have no standard deviation (i.e., they have zero std
deviation). So, consider this statement when answering question (c) below.

You are required to:

a) Calculate the expected return and standard deviation of Delta Ltd and the Chev.
Show the relevant formulae. (18 marks)

b) Calculate the expected return of your aunt’s portfolio. Show the relevant formula.
(4 marks)

c) Calculate the total risk of your aunt’s portfolio. Show the relevant formula.
(6 marks)
Solution:

a) Expected returns and standard deviations

Expected returns: rˆ   Pri  ri

i 1

Std deviations:  2   Pri  (ri  rˆ) 2

i 1

State Prob Chev Delta

rM rM x (rM – r̂M ) (rM – r̂M )2 x Pri rD rD x Pri (rD – r̂ D ) (rD ‐ r̂ D )2
Pri x Pri

G 0,1 –20 –2,00 –30,90 95,48 –20 –2,00 –36,00 129,60

N 0,6 13 7,80 2,10 2,65 15 9,00 –1,00 0,60
R 0,3 17 5,10 6,10 11,16 30 9,00 14,00 58,80

r̂ 10,90 16,00
% %
Variance 109,29 189,00
Standard 10,45% 13,75%
deviation

b) Expected return on portfolio of Delta and Treasury Bills (Chev Ltd)

n
Formula 10.9: rˆp   w  rˆ
i 1
i i

= (0,4 x 16%) + (0,6 x 8%) = 11,2%

c) Total risk of a portfolio is measured by standard deviation

Formula 10.10:  p  wA A  wB B  2wA wB CovrA ,rB

2 2 2 2 2
 Treasury Bills are risk‐free securities. As such, they have no standard deviation (total risk), no
systematic risk (=0), and no correlation of returns with other securities

 P  (0.4) 2 (189.00) (0.6) 2 (0) 2(0.4)(0.6) (0)

 P  ( 30.24) (0) ( 0)

P = 5,50%

QUESTION 2 (20 MARKS)

You are given the following return/probability characteristics in respect of two securities:

Security A

State of the Probability of this state Anticipated rate of return if

economy occurring this state occurs
Boom 0.2 40%
Normal 0.5 20%
Recession 0.3 -10%

Security B

State of the Probability of this state Anticipated rate of return if

economy occurring this state occurs
Boom 0.2 -10%
Normal 0.5 20%
Recession 0.3 40%

The intention is to combine Security A with Security B to form a two-asset portfolio.

REQUIRED:

(a) Calculate the expected return and standard deviation of each security. (8)

(b) Calculate the covariance and correlation coefficient between the two
securities. (4)

(c) Calculate the expected return and standard deviation if one invests
50% in Security A and 50% in Security B. (4)

(d) Using the statistics calculated above comment on whether diversification has been
achieved by combining the two securities. (4)

Solution:

(a) Expected return (Security A) = (0.2 × 40%) + (0.5 × 20%) + (0.3 × -10%) = 15%

Expected return (Security B) = (0.2 × -10%) + (0.5 × 20%) + (0.3 × 40%) = 20%

² 0.2(40-15 + 0.5 (20-15 0.3 10 15

= 0.0325
= 0.1802775

² 0.2(-10-20 + 0.5 (20-20 0.3 40 20

= 0.03
= 0.173205

(b) COV (A,B) = 0.2(0.4-0.15)(-0.1-0.2) + 0.5(0.2-0.15)(0.2-0.2) + 0.3(-0.1-0.15)(0.4-0.2)

= -0.030
.
Correlation coefficient = = - 0.96
. .

(c) = (0.5 × 15%) + (0.5 × 20%)

= 17.5%

/
= [(0.5 0.1802775 ) + (0.5 0.173205 ) + (2 × 0.5 × 0.5 × - 0.03)]
= 0.025
(d) Yes, the two are negatively correlated (-0, 96) therefore, the returns move in opposite
directions.